Ability to Repay and Qualified Mortgage under the Dodd – Frank act

Banker Resource October 7, 2013 — 1,079 views

What are Mortgages?

A mortgage is a loan acquired using real estate as collateral to the lender. The word ‘Mortgage’ is a technical term from French law, which literally translated, means death contract. A mortgage is so named because the contract comes to an end, or dies when the borrower repays the principal and interest to the lender, or when the borrower is unable to pay back the mortgage loan within the allotted time period, in which case the lender gains ownership of the real property pledged as collateral by the lender (Foreclosure).

In today’s economically unstable scenario, where money supply is limited and scarce, not all people can afford loans by any means other than a mortgage; however this ability to borrow comes with a heavy risk, as the inability to pay results in loss of the mortgaged property. All over the world, several people take up loans against property to fund expenditure, mostly educational or marital. This contract between the lender and the borrower has often been abused by both parties, with borrowers pledging properties that do not legally belong to them, and lenders that impose unfair payment conditions and time frames, without considering the lender’s ability to repay the mortgage, resulting in unfair foreclosure and loss of real property.

‘Ability–to –Repay’ Rule under the Dodd–Frank Act: What it means for Consumers

The Dodd-Frank Act will ensure that lenders take certain factors related to the borrower into consideration, before fixing installment repayment amounts. Essentially, it is a mandate for a lender to assess the financial stability of the candidate, his earning potential and capability to successfully pay back the loan with interest due; if a candidate seeking a mortgage is found to be in a weak financial potential with earnings too low to repay the loan, the lender cannot grant the loan against any real property the borrower may possess. This results in the creation of a stable loan facility, known as a Qualified Mortgage (QM). Apart from the safety of the borrower’s property and fair repayment and redemption, Qualified Mortgage rules also ensure that ethical lenders do not have to compete with other lenders that may use illegal methods to continue exploiting customers. Some Qualified Mortgage rules are:

Interest-only period – Qualified mortgages cannot have a period wherein the lender pays interest only, without paying the principal amount.

No Negative Amortization - The principal amount of the loan cannot increase over time, if the borrower is making payments.

No Balloon Payments – Borrowers will not have to pay installments that are larger than their predetermined monthly installment, however in some cases balloon payments are allowed.

30 Years or less – Qualified mortgages must not have terms lasting beyond a 30 year period.

Fixed Amount of Income Spent on Debt – Most QMs require that the monthly expenditure of the borrower towards debt, not exceed 43 percent of his/her monthly income before tax deductions.